The Microhoo Fallout

By eWEEK Staff  |  Posted 2008-05-09

The Microhoo Fallout

Microsoft's withdrawal of its offer for Yahoo ended a three-month saga replete with big bucks, big egos and big implications-for the companies involved, for their customers and for the industry in general.

Even after Microsoft raised its bid for Yahoo by $5 billion, to $47.5 billion, negotiations fell through. Microsoft CEO Steve Ballmer said his company increased its offer to $33 per share-from the $31-per-share cash-and-stock bid that it initially made Feb. 1-but that Yahoo was looking for $37 a share.

"Despite our best efforts, including raising our bid by roughly $5 billion, Yahoo has not moved toward accepting our offer," Ballmer said in a statement. "After careful consideration, we believe the economics demanded by Yahoo do not make sense for us, and it is in the best interests of Microsoft stockholders, employees and other stakeholders to withdraw our proposal."

Microsoft sought to buy Yahoo to gain a stronger foothold in its battle with Web search leader Google, which is rapidly expanding into the software maker's own turf with new Web-based applications.

Indeed, the failure of Microsoft to acquire Yahoo could echo in the future of the enterprise market, with Google emerging as the lead horse in the race, according to Interarbor Solutions analyst Dana Gardner. Microsoft's abandonment of its Google bid will not only keep Google at the head of the online search and advertising markets, but could also have an impact on the future of the enterprise market.

Google is a relatively small player in the enterprise, selling search appliances to businesses and a collaboration suite that it hosts on its own servers as part of its cloud-based Internet services strategy. All told, these products are believed to constitute only 2 percent of the company's revenue.

Click here for 10 things we learned from the Microsoft-Yahoo fallout. 

But as the computing landscape shifts increasingly toward cloud computing, Gardner said, Microsoft's traditional client/server and packaged software model will be threatened. Businesses are already looking to use applications that Google hosts in its own data centers. Microsoft wants to get to the same place and needs Yahoo-or a company like it-to help do it.

"There's a great deal of consensus that the older approach of a client/server-based architecture is cost-inefficient," Gardner said, adding that the cost of maintaining a PC in many enterprises is more than $1,000 a month.

Moreover, Microsoft's laborious Windows Vista operating system rollout hasn't assuaged any of these pains, meaning businesses will look at alternatives such as cloud-based computing or SAAS (software as a service).

In effect, if a company like Google lets customers use applications for $12 per user per month, more businesses will be compelled to look at the cloud, Gardner said: "This will come down to a competition of cost. Microsoft is at a disadvantage because it's transitioning from a previous high-margin, on-premises software business to a more low-margin, high-volume cloud-based business."

What Yahoo brings to the table as Microsoft attempts to dig into the cloud is a large audience in established Western markets, according to Ovum analyst David Mitchell.

"[Yahoo's audience] would have provided a valuable additional customer base and distribution potential for Microsoft cloud-based offerings that are emerging and that will continue to emerge at an ever-increasing rate-with Yahoo engineering capabilities helping the acceleration of cloud services coming to market," Mitchell said. "Microsoft needs to move on quickly rather than entering any period of mourning over what might have been."


Back to the Starting Line

Microsoft's decision to withdraw its offer for Yahoo probably saved both companies a lot of grief, but the months-long soap opera also weakened both companies to some degree and returned them to where they were before it all began-trying to figure out how to carve out some space in the online marketing arena now dominated by Google.

"If you're Google, you have to ... have a smile on your face," said Laura DiDio, an analyst with Yankee Group. Google officials won't get complacent, "but this buys you time. Your opponents ... have not only been weakened, but they'll be distracted by deciding what will be the next move."

Analysts said Microsoft and CEO Ballmer will have to readjust their vision, but that the company is already holding some major assets, including its diverse product portfolio and the hundreds of millions of users it does business with every day.

The real pressure now is on Yahoo CEO Jerry Yang, who made various moves to prove to Microsoft and the industry that his company is worth more than the $33 per share that Microsoft finally ended up offering. In the end, Microsoft said no, and now Yang must hope that the various initiatives he put in place will push his company forward, particularly in light of the 15 percent or more drop Yahoo's stock took after Microsoft announced its decision to drop its bid.

For a timeline of Microsoft's pursuit of Yahoo, click here. 

Yang also has to decide how to handle a skeptical group of shareholders, half of whom wanted the deal to go through and more than half of whom also own stock in Microsoft, DiDio said. Already, class-action lawsuits have been filed against Yang and Yahoo's board for failing to make a deal with Microsoft.

"Yang is really in the hot seat," DiDio said, adding that if Yahoo's competition was anything but a red-hot company like Google, its situation would be considered favorable. "[Yang's] initiatives, again, in any other market and on equal footing with the competition, are good. But in this market, good enough is not good enough."

Charlene Li, an analyst with Forrester Research, agreed.

"With the Microsoft acquisition threat fading, Yahoo has been given a reprieve, but it must explain and execute on a strategy that supports their belief that the company is worth $37 a share-or face another round of acquisition attempts and shareholder revolt," Li said in a blog post May 4.


Big Distraction

Analysts also said Microsoft dodged a bullet by pulling back from the Yahoo deal because the issues around integrating Yahoo into Microsoft would have been significant.

"Yahoo + Microsoft would have been a disaster," Forrester analyst George Colony said in a May 4 blog. "The best and the brightest from Yahoo would have gone to Google, the culture clash would have been destructive, it would have put Microsoft back in the sights of the regulators. And Yahoo wouldn't have helped Microsoft with its biggest task at hand-adapting to the emerging executable Internet software model."

Ballmer must now decide how to rework the company and its products to better compete in the online world against Google.

"Ballmer will have to reform: the culture, the people, the company's speed, how it sees software (it's not on shiny disks anymore), its design sense, its quality standards, its tired and annoying strategy of migrating its customers through predictable software versions, its old method of developing software (which produced the Vista flop)," Colony wrote.

Forrester Research's Li said Microsoft must play to its strengths to achieve this reformation.

"Rather than continue to chase Google's dominant search position, Microsoft should redefine the -battle' to one where search is an integrated part of the marketing mix," she said. "Microsoft has assets and relationships that [Google] doesn't have: 400 million user relationships through communication tools like Hotmail and Messenger, the aQuantive acquisition , [a] strong display advertising business, and investments/relationships like Facebook."

What Microsoft needs to add to this mix is a strong search engine, a key issue moving forward, Li added.

IT professionals contacted by eWEEK, many of whom are Microsoft customers, hope that Microsoft can keep its eye on core enterprise needs amid all the business machinations.

 "We did not see an acquisition of Yahoo having any direct benefit to us," said Tom Miller, senior director of IT at VNUS Medical Technologies and an eWEEK Corporate Partner. "We did have concern that it would distract Microsoft from its core business as they tried to join the two different cultures."

Karl Herleman, CIO at Miami Dade College and an eWEEK Corporate Partner, said the merger wouldn't have made a big difference in the day-to-day operations of his organization, but that he was hopeful that a Yahoo acquisition would have strengthened Microsoft's position in the cloud. "[The merger] would have signaled that they are going to compete aggressively with Google and, hopefully, in the long run provide cost-effective solutions in the Internet cloud."

Herleman may get his wish, as the fat lady seems not to have sung yet.

Microsoft officials are talking it down, but there is the real possibility that, after a few months, Microsoft could come back for another try at Yahoo, particularly if Yang fails to get the company moving in the right direction. Yang already has told reporters since Microsoft dropped the deal that he would be open to further talks.

At the same time, there have been reports that Microsoft has begun informal acquisition discussions with Facebook (Microsoft currently owns a relatively small stake in Facebook), Time Warner is talking with Yahoo about unloading AOL, and Google may be providing ad and search services to Yahoo.

With regard to that last point, Yahoo needs to be careful, said Ovum's Mitchell.

"Deepening the relationship with Google may be part of that plan, but this is where Yahoo needs to take care," Mitchell said. "The advertising relationship with Google may well have been attractive when Microsoft was chasing Yahoo, as something akin to a poison-pill clause, but it raises a serious question for an independent Yahoo. The basic question is, 'What does Yahoo want to be?'"

Yahoo and Yang will have to ask themselves that question should Microsoft come courting again-likely, with less in its pocket than the $33 per share last offered.

Yang "tried to bluff them," Yankee Group's DiDio said, "and he may have overplayed his hand."

Clint Boulton, Jeff Burt, Joe Wilcox and Debra Donston contributed to this story.


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